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A Better Alternative For Diversified Alternatives

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Alternative investments are generally defined as non-traditional assets, meaning the usual fare of stocks and bonds do not dwell in the alternatives space. Historically, alternatives sport low correlations to equity and fixed income assets, meaning alternatives can play an important role in adding diversity to investment portfolios.

The alternatives space includes strategies such as commodities, hedge funds, private equity and real estate, among other assets. Previously, alternative investments were a territory reserved for institutional or high net worth accredited investors, but exchange traded funds (ETFs) are increasing the accessibility of alternative strategies.

The JPMorgan Diversified Alternatives ETF (JPHF) brings a diverse approach to alternative and hedge fund strategies. Strategy diversification is a cornerstone of JPHF’s methodology. Focusing on diversification can reduce volatility and potentially boost long-term, total returns. Historical data suggest there are clear benefits in diversified hedge fund strategies.

In evaluating hedge strategies, some novice investors may be apt to ignore the fact that a strategy that proves efficacious one year can be a laggard the following year. This is a scenario similar to factor investing, one that underscores the utility of multi-factor ETFs. For example, growth stocks could be hot in a particular year, but the following year could see market participants favor low volatility, quality or value stocks while eschewing growth.

The chart below paints the picture of how infrequently a given year’s best-performing hedge fund strategies maintain or regain that status. In the 17-year period from 1997 through 2013, there were only two occasions in which one year’s best-performing hedge fund strategy was also the top strategy in the following year.

Chart Courtesy of Lazard Asset Management

Bottom line: Picking winning hedge fund strategies is, arguably, no easier than stock-picking or identifying the top investment factors leading into a new year. JPHF’s bottom-up, rules-based approach provides investors with exposure to multiple strategies, eliminating the strategy-evaluating conundrum.

As of the end of 2017, JPHF featured long/short equity, event-driven and macro-based strategies in its lineup. In the fourth quarter, the ETF beat its benchmark, the BofA Merrill Lynch 3-Month U.S. Treasury Bill Index. Since inception, JPHF has returned 3.98% compared to just 0.76% for the BofA Merrill Lynch 3-Month U.S. Treasury Bill Index.

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JPHF’s long/short strategy involves simultaneously investing in equities the fund’s managers believe are poised to generate positive returns and shorting stocks the managers view as unattractive based on multiple factors.

In 2017, JPHF’s equity long/short sub-strategy benefited from the rise in global equity markets over the quarter; however, factor exposures detracted from performance,” according to JPMorgan Asset Management. “Value and small-cap stocks underperformed, though there were signs of recovery in December.”

Last year, macro hedge funds delivered an average annual return of just 2.25%, barely more than a quarter of the industry-wide average. That data point underscores the utility of JPHF multi-strategy approach. While the fund features macro exposure, it was not fully restrained by the macro strategy’s laggard status in 2017.

Still, JPHF is poised to benefit from a potential rebound in macro strategies this year without sacrificing any of the ETF’s diversification benefits.

“Macro factor spreads remain compressed in both fixed income and developed market foreign exchange (FX), but are more in line with long-term averages in commodities,” said JPMorgan Asset Management.

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